An old model with new opportunities

Dirk Trautmann, of Norton Rose, writing in the latest edition of the firm's 'legalseas' publication, says, “In 2003, KG companies achieved record investment levels, with equity collected reaching €2.3 billion. The prospects for this year also look good. This, combined with historically strong returns of KGs (with an average annual post-tax return of 15 per cent on equity) and the lack of alternative tax-driven structures in the German market has lead to an increasing number of KG structures.”

Trautmann explains that, “The Kommanditgesellschaft (KG) is a limited liability partnership with a limited liability company as general partner, and private investors as limited partners. The KG purchases vessels and charters them to shipping companies. The purchase of the vessel is financed by equity provided by the investors (usually 35-50 per cent) and a bank loan (usually 50-65 per cent) secured by a first ranking mortgage over the vessel.”

Benefits of the KG structure

Noting that the main attractions of the KG structure are the benefits available under German tax law, particularly tonnage tax, Trautmann says, “As the KG is tax-transparent, tax on relevant profits and losses is applied on the investor level. Under the tonnage tax regime, income tax is not calculated on the basis of the KG’s actual profits, but rather on the net tonnage of the ship. The leads to a negligible tax on the KG’s profits.

“Currently, most structures combine tax benefits from losses with the application of tonnage tax. A recent change in the tax laws marks the phasing-out of this combi-model and by January 1, 2007, it will disappear. From then on, the KG will only be able to opt for tonnage tax treatment starting with the purchase of the vessel or starting ten years after the purchase.

Benefits for the shipowner

“KG structures give shipowners the opportunity to enter into medium to long-term charters at a lower rate than the current high spot market rates. Most KG investors look to a secure long-term return rather than short-term profits. They are, therefore, willing to accept lower charter rates, provided these are fixed for a number of years (usually four to six years for commoditised vessels, but longer for bigger/more specialised vessels). In some cases, shipowners may also be able to sell used vessels to a KG, thereby realising part of the market value of the vessel.

What does the future hold for KG finance?

“The rapid growth in the market has led some experts to warn that there will not be enough containerships and tankers (traditionally the most popular vessel types for KG financing) available to satisfy investors’ appetite. This brings opportunities for new vessel types, in particular LNG carriers, to be financed through KG structures.

“In the case of LNG carriers, the investors’ interest in the safe long-term return through the charter fits well with the shipowner’s interest to have a ship available for the long-term. As the market for these types of vessels is less fluid, the KG (and debt providers) will put greater reliance on the shipowner’s financial strength than in traditional containership financing.

“They will also need to look closely at the projects for which the LNG carrier will be used. It may be possible to include a purchase option in favour of the charterer – this is particularly important in LNG financing as the lifetime of an LNG carrier exceeds the usual terms of a KG structure.

“At the moment there is little doubt that the success of KG ship finance structures will continue.”